What Determines the Price of Gold?
What to know about the pricing mechanism of gold before investing in it? This article has a full list of all the factors that determine the price of gold.
Major elements that determine the price of gold: the value of the dollar, the future inflation expectation, and also the demand on gold.
Price of Gold and the Dollar Value: an Inverse Relation
Ever since the collapse of the Bretton Woods system in 1971 from the so-called Nixon Shock, the U.S. dollar has been the sole currency used in pricing gold for gold trading around the world. Any change in the dollar value relative to other currencies, all else being equal, inversely influences the price of gold.
Change in the Dollar Value
Trade deficit, international capital inflows, mainly Treasure issuance and corporate borrowing, and the perceived health of the U.S. economy relative to the rest of the world, especially nowadays when comparing to the emerging markets, are the main causes affecting the value of the dollar. For example, a widened trade deficit, a decreased capital flow into the U.S., and a worse perceived U.S. economy likely have lowered the demand on the dollar and thus its value as traded on the foreign exchange market.
Change in Inflation Expectation
Inflation outlook is another factor that determines the price of gold, as gold is the most classic hedge against inflation in the current fiat monetary system. The state of the U.S. economy, its government’s fiscal policy, and the Fed’s monetary policy, namely interest rates and money supply, all influence people’s future inflation expectations. Confidence in policy makers’ ability to fight against future inflation normally helps stabilizing the gold market.
Change in Gold Demand
Demand and supply ultimately determines the price of gold. Industrial and jewelry use, central bank buying, and private investing, including today’s gold ETFs to a large extent, are the well-known sources of demand on gold. Newly mined gold and previously horded gold constitute the supply, which is relatively inelastic when reacting to any sudden change in gold demand.
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